Every contractor wants to make a profit. While it’s not the published objective of many businesses, turning a profit is at the core of every one and is the number one factor in most critical decisions made, behind cashflow. When assessing the direction of your business and deciding what jobs to bid for, or deciding on what rates to charge for your service work, you need to consider the impact of discounting.
The average business incurs many fixed costs such as overheads, rent, power, vehicles and wages, which don’t change irrespective of the amount of work it’s doing. When discounting, very few contractors appreciate the true cost of the discount or how it will impact their bottom line. Costs don’t change, it will still cost the same amount to complete the job but the net revenue will decrease when a discount is given.
Although the same for project or estimated works, if we consider service/do-and-charge work for this example, it can be seen that a business needs to increase the number of service jobs it completes to recover any discount given. You need to work more to cover the reduced profit on each job. When applying discounts, many businesses fail to consider the amount of additional work required to achieve the same profit. The table below illustrates the cost of discounting:
|Gross Profit Margin on Jobs|
Firstly, decide what your current margin is and then look at any discount you may consider offering your customer. Match the two up and you will see the increased percentage of work required to achieve the same level of profit within your business.
Increased competition tends to drive rate discounting, resulting in companies reducing their labour rates in order to attract or retain particular customers, contracts or quotes. The real trick in understanding the table above is to work out the true cost of your employees. Once the “cost per hour” is calculated, the margin you are making on labour can then be calculated.
Many companies are hesitant to raise rates and often believe that they would lose too much business in doing so. Once you understand the cost of employees and what margin you make on labour, the volume of sales you can lose while retaining profit can be calculated as shown in the table below.
|Gross Profit Margin on Service|
It is important to keep in mind that profit margins are key to the success of a business. Seemingly no one is surprised when companies liquidate even though they have been continually winning work. It’s not enough to win work or keep busy – it needs to be profitable.
Written by Gerard Lyons, Business Development Manager – Victoria